Morning comment: RBA not quite so dovish

Chris Scicluna
Emily Nicol
Mantas Vanagas

Wall Street continued in a positive direction yesterday as the S&P500 posted a technology-enhanced 0.7% gain and risk-on behaviour drove a modest 2-3bp increase in Treasury yields. But Japan’s equities were little changed today (the TOPIX closed up just 0.1%), and the yen and (inevitably) JGBs were stable too, even as the local service sector PMI painted a slightly firmer picture of the economy than last week’s disappointingly soft manufacturing report. By contrast Australia’s ASX200 rose a strong 2.0%, with bank stocks rallying more than 5% as investors reacted to yesterday’s final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which made recommendations that were less onerous than had been feared. Meanwhile, despite generally soft data, the A$ and Aussie bond yields moved higher after the RBA appeared to broadly maintain its policy stance, rather than validate the possible rate cut that investors have been mulling, even after downwardly revising its outlook for economic growth and inflation (see plenty more on this below). Markets in mainland China, Hong Kong, Taiwan Singapore and South Korea were all on holiday today.

This week’s Japanese economic data flow got underway today with the release of the service sector and composite PMIs for January. In contrast with the marked deterioration recorded in the headline manufacturing PMI, the headline services PMI rose a modest 0.6pt to 51.6 in January – slightly above last year’s average – while the new orders component edged up 0.1pt to 52.1. Elsewhere in the survey, the employment component bucked the trend with a 0.6pt decline to 50.9, but the output price index rose for a third consecutive month by 0.3pt to 52.3 – the highest reading for 6 months. The input price index edged down 0.2pts to an 8-month low of 53.6, however.

Given the scale of the deterioration in the manufacturing output PMI, the headline composite index fell 1.1pts to a 4-month low of 50.9 in January – a result that suggests that the economy has made a soft start to Q1 following a probable rebound in activity in Q4. With respect to inflation, the composite output price index rose 0.2pt to a 3-month high of 52.2 but the input price index declined 0.5pt to a 9-month low of 54.9.

Euro area:
Today will also bring the final services and composite PMIs for January from the euro area, which are likely to confirm the findings of the flash estimates to suggest a further weakening in economic conditions at the start of 2019. In particular, the flash headline euro area services index fell to a 65-month low of 50.8. And with last week’s manufacturing PMI confirmed at 50.5, its lowest level since November 2014, the composite PMI is also likely to align with the flash estimate, which declined 0.4pt in January to 51.1, a 5½-year low. At the country level, the Italian PMIs should attract most attention – if last week’s dire manufacturing PMI (just 47.8, also the lowest in more than five years) is anything to go by, we’ll see a sub-50 reading that raises the prospect of a third consecutive negative reading for quarterly Italian growth in Q1.

This morning will also bring euro area retail sales figures for December, which are bound to show some payback for the solid increases in the first two months of Q4, not least given the exceptionally sharp decline (>4%M/M) already reported in Germany that month. In the markets, Germany will sell 2026 and 2046 index-linked bonds.

Today brings several UK releases of note, including January’s services and composite PMIs, with expectations for the headline services index to be little changed from December’s reading of 51.2. But against the backdrop of heightened uncertainty surrounding Brexit, risks to this outturn seem skewed to the downside. Certainly, the manufacturing output PMI fell for a second successive month in January to 51.4, its lowest level since July 2016. And yesterday’s construction survey was undoubtedly weak, with the headline PMI down 2.2pts to a ten-month low of 50.6. So, assuming the services PMI is unchanged at 51.2, the PMI surveys would imply GDP growth of zero at the start of the year, having signalled growth of just 0.1%Q/Q in Q4.

However, this morning’s BRC Retail Sales Monitor surprised on the upside in January, with like-for-like sales up 1.8%Y/Y, the strongest pace since May. Admittedly, this likely represents some payback for the weakness seen through the second half of last year and the worst December performance in a decade – indeed, smoothing out monthly volatility, like-for-like sales were up just 0.1%3M/Y in January. Growth was supported by sales of food, which rose 1.3%3M/Y. But despite solid growth in online sales, overall spending on non-food items continued to decline (-0.8%3M/Y). And faced with increased Brexit uncertainties and the ending of post-Christmas discounting, we would expect consumers to scale back their spending over coming months, particularly on big-ticket items. Certainly, we would expect to see a soft reading from the latest new car registration data later this morning.

In the US, the data focus today will be the non-manufacturing ISM and services PMI reports for January. With the labour market and the economy on a relatively firm growth track, the ISM non-manufacturing index is expected to post a reading in the upper-50 region, albeit likely slightly below the average of 58.9 seen in 2018. In the markets, the US Treasury will auction 3-year notes.

A very busy day in Australia saw the release of the outcome of the RBA’s February Board meeting, together with a number of key economic reports.

Beginning with the RBA, as widely expected, once again the Bank retained the cash rate at 1.5%. And the concluding paragraph of the post-meeting statement, which summarises the Bank’s stance, was yet again completely unchanged from that issued previously. Amongst other things, that paragraph continues to observe that: “Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual.” This suggests that the Bank continues to expect that its next move will be a policy tightening, albeit not for quite some time.

That said, as expected, the Bank’s statement did move in a somewhat more dovish direction with the outlook for GDP growth and inflation now slightly weaker than foreseen previously. According to the statement, the central scenario is for the Australian economy to grow by “around 3%” this year and by “a little less” in 2020. Previously the Bank had forecast growth of 3¼% in both 2019 and 2020. The Bank views that global outlook as still “reasonable” but did note that “downside risks have increased”. Domestically the Bank noted greater-than-expected weakness in household consumption and incomes in Q3 and stated that the main domestic uncertainty remains around the outlook for consumption spending and the effect of falling housing prices, especially in Sydney and Melbourne. On the other hand, the Bank continues to take some comfort from the tightness of the labour market, which is still expected to see a further gradual lift in wage growth over time. As a result, the Bank continues to forecast that underlying inflation will pick up gradually over the next couple of years, albeit that pick-up is now forecast to take a little longer than earlier expected. The central scenario is for underlying inflation to be 2% this year and 2¼% in 2020. Previously the Bank had forecast that inflation would be 2¼% in both years.

Given the market’s very dovish bias, the relative small changes in the Bank’s forecasts for growth and inflation led to a modest 2bp lift in Australian bond yields and a ½ cent lift in the Aussie dollar. Attention will now turn to tomorrow’s speech by Governor Philip Lowe to the National Press Club, while the Bank will release its full updated Statement on Monetary Policy on Friday. The additional commentary should confirm that the RBA views Australian monetary policy settings as most likely to remain unchanged for the whole of this year, with neither a policy tightening nor policy easing seeming to be required at this stage.

Turning to the day’s data flow, the RBA’s concerns about household consumption spending would not have been eased by the retail sales report for December. Total spending fell 0.4%M/M, largely erasing an upwardly-revised 0.5%M/M increase in November. Base effects saw annual growth rise to 3.7%Y/Y, however. While higher spending was recorded on food and at restaurants, spending on apparel and household goods fell sharply. Importantly, inflation-adjusted spending rose just 0.1%Q/Q in Q4 – even slower than the 0.2%Q/Q growth recorded in Q3 – which was well below market expectations. Spending fell across four of the six categories, but spending on apparel and at department stores rose. This provides a soft start to GDP calculations for the quarter.

At face value somewhat stronger news was provided by the trade report, which revealed a very large trade surplus of A$3.68bn in December – well above market expectations – following an upwardly-revised surplus of A$2.26bn in November. However, the largest surplus in two years – and the second-largest on record – owed much to a 5.7%M/M decline in imports (down 0.9%Y/Y). While this partly reflected lower imports of intermediates – influenced by lower fuel prices – imports of both consumer and capex goods also declined sharply in December, with imports of motor vehicles and aircraft down especially sharply. Exports fell 1.6%M/M but nevertheless remained up a strong 16.2%Y/Y, with non-rural exports up an even-stronger 22.8%Y/Y. The ABS also reported that the seasonally-adjusted surplus in Q4 was about A$2bn higher than in Q3 – an improvement that can be readily explained by a rise in the terms of trade during the quarter. While positive for incomes, this implies a weak picture for net export volumes, adding to signs that real GDP growth will be soft in Q4.

More contemporary information on the economy was provided by the service sector PMI reports for January, which also had a soft tone. The extremely volatile AiG index slumped 7.4pts to 44.3, marking the weakest reading since November 2014. The CBA PMI was confirmed at its flash reading of 51.0 – still expansionary but down 1.7pts for the month and at the lowest level seen in the brief history of the survey. Finally, the ANZ-Roy Morgan consumer confidence index rose 1.6pts to 118.1 last week, which is the highest reading since early December and still a little above the survey average.

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